Different Investment Styles For Investing In The Stock Market

There are a lot of investment styles you can use when you participate in the stock market. We review how they work.

There are many schools of thought when it comes to investing, but the main rules still stand out:(1) Invest early. (2) Invest regularly. (3) Stay invested.

After following these three rules for sometime, you should find yourself happily sitting on a nice pile of dough. But having waded through so many finance and investing books through the years, I continue to be fascinated by the various investment styles that have been used by so many successful investors and fund managers to generate that pile of dough. Care to know a little about some of them?

When you plunk down your money into a stock or fund, you release that money into a market heavily studied by investment strategists and money gurus. Don’t worry since many of them are already working for you, when you’re invested in mutual funds. But in case you’ve been doing your own investing without a professional involved, it may be good to know a few of the investing styles used out there by market players who constantly want to gain an edge. Here are some descriptions of contrasting strategies that exist in the market place and my own confessions about which styles I subscribe to.

Investment Styles For Any Portfolio

#1 Technical Versus Fundamental Analysis

I’ve described technical analysis versus fundamental analysis in the past and even included pretty pictures in the mix. Technical analysis involves using timing indicators and triggers. I’ve encountered a few folks who have decided that trading was the way to go to make some bucks. They play the market in their spare time by trading on volatility. Traders love it when market prices shift dramatically because that’s when they make money on their positions. A quiet and boring market is a money loser for them. On the other hand, fundamental analysts are most of us who are long-term investors. We keep the money in the market and minimize trades because we’re banking on the solid earnings of corporations and a nicely running economy to keep our money growing. On this note, I’m definitely on the camp of long term investing.

#2 Growth Versus Value

Value investors are those who buy lower valued stocks based on fundamentals and corporate balance sheets. They are looking to buy stocks of businesses that are currently unpopular, underestimated in terms of earnings or undiscovered by the market herd. They hope to buy stock at low price points in order to reap the largest gains when the tide turns in favor of these stocks. Meanwhile, growth investors favor stocks that have expected high future growth rates. It doesn’t matter whether a growth stock is expensive in terms of its price/earnings multiple, just as long as its future is bright and earnings remain strong. Small stocks are often in this realm as they go through growth spurts in a huge way. I personally put my money in blended funds — those that have equal representation in growth and value equities since I’d like to have some level of participation in whatever style is fashionable at any one time.

#3 Contrarian Versus Momentum

Contrarian investors like to go against the herd. Either buying stocks that everyone hates or going against what the investing crowd does. When the market dies, they buy. Most of the time, they just sit quietly in the wings, waiting for the opportunity to buy on dips. An example of contrarian investing is the Dogs of The Dow approach. Whereas momentum investors are just the opposite: they are what I call the “rah-rah” investors. They love to pump up the market. When things are going well, they buy on strength hoping to catch the momentum of the bull. The “momo” investors’ motto: Buy High, Sell Even Higher. I don’t know about you but I find it a challenge to buy when the market has been surging for some time. I’m really a pseudo-contrarian at heart.

#4 Active Versus Passive (Indexing)

Do you like to fuss over your portfolio? If you are, or if you’ve invested in what they call “actively managed mutual funds”, then you’re pursuing the active investment style. You’re an active investor if you tinker with your portfolio a lot to try to beat market returns, quite often racking up a good amount of transactional activity. If you’ve sent your money off to funds that have fund managers doing investment research and trades in your behalf, then by association, you’re an active investor. If in the meantime your investments are simply tracking an index determined by a third party, then you’re investing “passively”.

So which approach is superior? Reports such as those provided by Lipper Analytical Services have trumpeted the fact that most actively managed equity mutual funds underperform the S & P 500 Index. I’d love to see some hard statistics on this, for sure, but this is a point that many “indexers” and passive investors like to boast about when justifying their love for index funds or index ETFs.

Indexing is a great way to go if you are ready to accept slight under-performance by funds that are tracking their actual indexes. Funds that follow indexes have slightly lower returns due to minimal management fees and transaction costs incurred by these funds. After all these years of investing, I’ve accepted indexing as my core investment style of choice, for the simplicity and convenience it offers me.

#5 Asset Allocation

It’s a no-brainer: practicing asset allocation and diversification by utilizing any or all of the aforementioned investment styles to achieve your financial goals are very wise moves. I’ve tried quite a number of strategies in the past that involved trading, shorting, leverage, concentrated positions, and so forth and nothing made me more money and gave me less headaches than long term investing using the passive or indexing approach. For average investors, I think this is the most reasonable and sensible way to invest. Unfortunately, many decide to go this route only after getting burned by the market at some point in their investing careers.

-ooOoo-

There are other investment styles such as those that involve choosing which market caps you’d like representation in (e.g. small to large company investing) or top down vs bottom up strategies. Sometimes it’s a pattern of behavior, at other times, it’s about following what’s in fashion. For further diversification, I’ve tried to find representation of these styles in my own portfolio as they can co-exist in various capacities. At first, these various styles can make your head spin but if you’re going for simplicity, nothing beats passive investing. It’s a good place to start…and end!

Image Credit: Thank you to AmazingIllusions.com for their fun images. This post first appeared on September 6, 2007

All good basic points. But what are the reasons why more people can’t/don’t invest or invest more?

I think it is becasue they make 5 basic mistakes: they are not prepared for life’s emergencies, they don’t get clear about priorities, they have a car payment, they have credit card payments, they have a bad home loan. The way I figue it they could hang on to an extra $1.2 million or so long term if they did not make these mistakes. Your thoughts?

Bob Pessemier, AFC, AAMS, CFE
Online personal money management classes at Top5Mistakes.com. Free until Oct 1 if you use the code TDL1 when you register.

SVB has summarized it nicely. Essentially we too are buy and hold index investors which not only seems rational for a long term investing horizon but also helps us maintain a healthy balance in life. We have witnessed how folks get sucked into this investing craze, day and night, while doing momentum trading or any other form of market timing. After few years they get burnt out and lose a lot of hair! Fortunately we came to the similar conclusion of passive index investing, early on. But we faced one problem – which indexes to choose from. Their definitions and coverages vary. For example Large Cap index from S&P, Dow, MSCI and Russell are all different. We did not find a single place where all of them were compared.

Cheers,
FIRE Finance

Brip BlapSeptember 6, 2007 at 8:35 pm

I have never seen definitive stats on it, but I wonder what percentage of people who are middle class (i.e. no huge inheritances or managed estate s or pro athlete salaries) who are fairly knowledgeable about personal finance are index investors. I would be willing to bet that majority of the people who study and understand finance and investing go for index funds and skip on the active investing.

As I said, I doubt there are any stats like this (any takers??) but my gut feel is that the informed investor realizes that beating the market is tough unless you make it your full time job. Even then you are at a huge disadvantage versus the funds and institutional investors – let alone versus the emotion-driven US market. I gave up and decided I had better things to do with my time than lose money on actively traded stocks…

DavidSeptember 6, 2007 at 10:13 pm

How much money should one invest to make it profitable? For someone who is new to investing I’m sure I would need a professional to help me out so the fees would be expensive? I have heard of so many horror stories of people losing their entire life savings to stocks that the word “stock has become sour in my mind.

@Bob,
When you have many other financial issues, investing may be of lower priority. It’s hard enough for many families to stay afloat and it’s not just because of bad choices — it could be bad luck, being stuck in a low-paying job and so forth. But you are right that knowing how to prioritize financial needs should be a first consideration. Take care of debts first, be disciplined about spending and saving and eventually, money will get freed up for investing.

@Fire Finance – yes, when faced with many indexes, asset allocation comes to the rescue :). Let each index represent!

@Brip Blap – I can’t believe it either but majority of people I know are ACTIVE investors or even DIY traders. It’s scary. No matter how much I talk to them about indexing, they think it’s boring and would rather spend the time trading. Their justification is that they have a 401K they don’t touch. Except it’s entirely in company stock!

@David,
I’ve never had to hire anyone to get started with investing. People lose their shirts with stocks because they take on risk that leads them to turn the stock market into a casino. Instead, you can invest in the stock market prudently. You can, for instance, consider dollar cost averaging if you don’t have much to invest. That’s a good strategy for beginning investors. You can do this by using an index fund, available through many no-load mutual fund companies such as T.Rowe Price, Vanguard, TIAA-CREF. Good luck!

MichelleSeptember 7, 2007 at 2:07 pm

Those are interesting photos. Why do you have shirt off in the first one? Is it supposed to be symbolic?
Also, I really think you should turn this into a little quiz, in the same style as those popular teenage girl quizzes “Does he like you?” or “Are you smelly?” That would make it more fun and interactive for people. Teenage girls love those things!

Michelle,
Actually, the photos came that way and I just stumbled upon them. I also wondered why the shirt was off on the first pic. I would have preferred if he kept the shirt on, IMHO ;D. Thanks for the fun suggestion on the quizzes, I shall try it next time. Though I’d say it may take a bit more creative thinking to pull it off well.

PinyoOctober 31, 2007 at 1:28 pm

Great overall summary. I am a strong believer of indexing, asset allocation, and diversification too. I have not tried technical analysis.

You should add a 4th rule: Write call options against your stocks each month for extra income. You have assets (stocks). Why not make them work for you. Write an out of the money call option and get some extra income each month. Probably get 5-6% per year in option premium without taking any additional risk (you are already taking the risk because you own the stocks). Free tutorial on how to do it (it’s easy) here.

There is no perfect way to always go up but part of being an investment veteran is learning when to hold on and when to let go. Are you watching the Japanese yen?

DIY InvestorApril 16, 2011 at 8:39 am

re: Brip Brap on who indexes. Read p. 52 of “The New CoffeeHouse Investor by Schultheis. He lists several state pension funds and the percentage of assets they index. For example, he reports that the State of Calif. indexes 85% and the State of New York indexes 75% of assets.

These funds hire the best and the brightest of the nation’s business schools including Harvard, Wharton etc.

Question: If anybody could beat the market by doing their own investing or hiring professional managers to beat the market wouldn’t it be these large funds?

I recommend to people to do what the big boys do.

Kathryn CApril 16, 2011 at 10:53 am

On indexing, there was a great article in the NY times last weekend. here’s the link.

I’m a big believer in indexing too, for the majority of my portfolio. Unless your’e doing something specialized like bank loans and need an active mutual fund (manager) for that. Here’s the NY Times article!

I love indexing as well. My take on investments is pretty much libertarian. That is, you do what you enjoy doing, what you like doing or what you’re ultimately comfortable doing. I happen to love index funds and ETFs. Why? No brainers y’all! I wish I had more time to study the markets and if I did, I would probably do a bit more experimentation. I do study the markets (or else I wouldn’t be writing much about it) but not to the point that I’d risk a good portion of my money on the information I uncover. I have some pretty basic rules: if I don’t trust the research on something (or haven’t put enough time on it), then my money won’t be going there. By default, it goes into passive investment funds which track the indexes. The work I see myself doing is in figuring out the right formula for sufficient diversification and asset exposure. On some occasions, I’ll be opportunistic with a smallish part of my portfolio, and that’s when I consult with my investment planner and pick her brains for ideas.

Justin @ MoneyIsTheRootApril 18, 2011 at 2:27 pm

I invest regularly! I make sure in doing so that I avoid most peaks and troughs. This is really a good investment strategy for the long term people.

Joey F.June 25, 2012 at 1:18 pm

There are several types of investors out there who commit their hard-earned bucks to the stock market (or other markets) to try to squeeze a little more from the savings they have. Some have decided to abandon their piggy banks for something more “exciting”. While others enter the market with a lot of planning involved.

There are investors who tend to be more conservative: they are careful with how they pick their stocks, and with how they time the market. For these people, most of their stock market timing endeavors consist of figuring out when to jump into the market at an optimal time in order to rebalance their portfolios. At the other end of the spectrum are those who love and enjoy picking stocks, performing short term day trades and figuring out how to beat market returns.

For those who are interested in stock picking, there’s also that cross section who cares to hear about what certain “financial gurus” have to say about the stock market.

Everyone has their own way of investing and there’s no right or wrong style, is there?